How Online Credit Card Payments Work

If you want to sell something online you need both a payment gateway and a merchant account. But, do you know the difference between a payment gateway and a merchant account? If you don’t, setting up an e-commerce website can get confusing and you could get hit with unexpected fees.

What is a Payment Gateway?

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Paying with the credit card has many benefits including convenience, easy tracking and security. And when Merchants use a payment gateway, they can accept all major credit card brands on their website, mobile device or retail store.

Paying with a credit card has three basic steps: Authorization, Capture and Settlement.

If you’ve purchased something using a credit card then you’ve seen authorization at work. A payment gateway is the service that processes credit card transactions for you. When your customers are buying something from your online store they enter their credit card numbers during the checkout process. Your e-commerce website sends that credit card information to your payment gateway to authorize the transaction and process the payment. This is Authorization.

After verifying the funds are available a hold is placed on the money. This is capture. Once the funds are captured, the merchant can hand over or ship the goods and be confident that they’ll be paid. However, the merchant doesn’t have their money yet. If the credit card information submitted to the payment gateway matches the information on file with the credit card company and the charge is approved, the payment gateway will then transfer the money from your customer’s credit card into your Merchant Account (see more on how a Merchant Account works below).

The process of transferring money from the customer’s credit card or bank account to the Merchant’s bank account is called Settlement.

Settlement usually occurs once each business day. During settlement, the banks connect to each other. The Payment Gateway begins the settlement process by aggregating the daily transaction details and sending them to the Merchant’s bank. The payment network then handles the settlement. Once settlement is complete, the buyer’s money is transferred to the merchant’s bank account. Meanwhile, the customer’s bank posts a charge on the customer’s account. The transaction is now complete and the purchase will show up on the customer’s credit card statement.

How a Merchant Account Works

Everybody talks about payment gateways and merchant accounts as if they are the same thing but they are not. Merchant accounts are really the more complicated of the two. The merchant account is basically an online bank account that will temporarily hold your money (you are the merchant) until it is moved into your actual bank account (see the “Capture” stage above). After a successful sale, money will be transferred into your merchant account and it will sit there for a few days, usually between 2 and 7 days, then, in most cases, it will automatically be transferred into your bank account – the one that you actually think of as your bank account where you deposit checks and so forth. You can sort of think of your merchant account as a temporary holding tank for the money that comes in from online sales.

Types of Merchant Accounts: Dedicated vs Aggregate

There are two different types of merchant accounts. A dedicated merchant account is an account set up just for you, the merchant. This is like your very own online bank account set up just for your online business. If you set up an account with a payment gateway like Authorize.net you will also get a dedicated merchant account. With a dedicated merchant account you can often negotiate custom rates for your sales. The rates are based on the volume of sales you process and the types of products you sell.

If you like the idea of having more control over your money and the ability to negotiate custom rates, you may want a dedicated merchant account. To get a dedicated merchant account you and your company will need to go through a fairly in depth credit check and underwriting process. This takes time and involves faxing over bank records and other information about yourself and your business.

An aggregate merchant account is one where your money gets dropped in a pool with a large number of other companies. Stripe and PayPal are examples of services that provide aggregate merchant accounts. You still need to provide some information about your company and the types of products you intend to sell, but the process of getting connected with an aggregate merchant account is far less complicated and faster. The downside is you have a little bit less control over how long it takes to get your money and you generally can’t negotiate the rates.

How You Get Your Money

With a dedicated merchant account (i.e. Authorize.net) most of the time will get your money in about 2 days. That means 2 days after the sale on your website, the money will be sitting in your normal, business bank account. With an aggregate merchant account it will usually take longer. For example, Stripe holds your money for 7 days before transferring it into your bank account. PayPal will hold your money in your PayPal account indefinitely until you either spend the money by paying for something with the money in your PayPal account or you request the money to be transferred to your bank account. Once you request the money to be transferred, it takes about 5 business days to arrive in your bank account.

Our Conclusion & Recommendation

Having set up a variety of e-commerce stores for our customers, it is our opinion that, unless you manage a large e-commerce store with high volume in transactions, the minor amount of savings you get from having your own dedicated merchant account is not at worth the lengthy amount of time and trouble you have to go through in the process to get one. The rate structures are very complicated with qualified and non-qualified rates and other fees that are charged to you. It is very hard to predict what your actual expenses are going to be and you almost always end up paying more than you think you are paying.

Our suggestion is that, if you manage a relatively small store, you will be better off using a payment gateway that offers an aggregate merchant account as part of their service like Stripe or PayPal. With Stripe there is no monthly fee, a single flat rate of 2.9% + $0.30 per transaction (as of this writing) and you can be up and running ready to accept live credit card payments in just a few minutes. If you’ve ever experienced the underwriting process for a dedicated merchant account you won’t believe how easy it is to get a Stripe or even a PayPal account.